If your investing and tax strategy for retirement includes tax-advantaged Roth accounts, you've probably heard about the IRS's five-year rule. The simple version says the Roth account needs to have been funded for five years before you withdraw any earnings—even after you've reached age 59½—or you could owe taxes.
The assets are transferred into an Inherited IRA held in your name. Money is available: At any time up until 12/31 of the tenth year after the year in which the account holder died, at which point all assets need to be fully distributed.
A Roth IRA is also subject to a five-year inheritance rule. The beneficiary must liquidate the entire value of the inherited IRA by Dec. 31 of the fifth year after the owner's death. No RMDs are required during this five-year period.
For traditional IRAs you must begin taking withdrawals, or Required Minimum Distributions (RMDs), starting at age 73*, (or 72 if you were born before July 1, 1949). The rules for making withdrawals from a Roth IRA are more nuanced, though generally you must be age 59½ and have held the account for five years.
The U.S. government charges a 10% penalty on early withdrawals from a Traditional IRA, and a state tax penalty may also apply. You can learn more at IRS Publication 590-B. Some types of home purchases are eligible. Funds must be used within 120 days, and there is a pre-tax lifetime limit of $10,000.
Mistake #1: Not Starting Your RMD on Time
The rules for RMD starting ages have undergone changes in recent years, leading to confusion among many individuals. In the past, the starting age for RMDs was 70½. However, as of 2023, the starting age stands at 73 and is set to increase to 75 in the future.
One inherited IRA tax management tip is to avoid immediately withdrawing a single lump sum from the IRA. Instead, wait until RMDs are due, or, if you got the IRA from a non-spouse, stretch withdrawals over 10 years. RMDs are taxable and can change your tax bracket and increase your overall tax burden.
If you're at least age 59½ and your Roth IRA has been open for at least five years, you can withdraw money tax- and penalty-free. See Roth IRA withdrawal rules.
The primary disadvantage of naming a trust as beneficiary is that the retirement plan's assets will be subjected to required minimum distribution payouts, which are calculated based on the life expectancy of the oldest beneficiary.
Spacing out distributions over 10-year period
A beneficiary may consider spacing out distributions over the ten-year period to benefit from tax-deferred appreciation while also managing taxes. If the beneficiary retires during those years, waiting to take distributions until then may lower the overall tax bill.
Required minimum distributions (RMDs) are the minimum amount that you must withdraw from certain tax-advantaged retirement accounts. They begin at age 72 or 73, depending on your circumstances and continue indefinitely. There is, unfortunately, no age when RMDs stop.
An inherited IRA may be taxable, depending on the type. If you inherit a Roth IRA, you're free of taxes. But with a traditional IRA, any amount you withdraw is subject to ordinary income taxes.
Some exceptions to the 5-year rule may apply, allowing you to make withdrawals without paying a penalty (but taxes may still apply). These include withdrawals up to $10,000 made for a first home purchase, if you become permanently and totally disabled, or for educational expenses.
Once a cumulative total of five (5) calendar years is reached during the student's lifetime s/he will never be an exempt individual as a student again.
The "guaranteed period" for an annuity is the initial period for which the annuity is guaranteed to be paid regardless of whether or not the individual dies during that specific period of time. The standard guaratee period is 5 years but it can also be pushed out to 10 years.
You can take distributions from your IRA (including your SEP-IRA or SIMPLE-IRA) at any time. There is no need to show a hardship to take a distribution. However, your distribution will be includible in your taxable income and it may be subject to a 10% additional tax if you're under age 59 1/2.
This 10-year rule has an exception for a surviving spouse, a child who has not reached the age of majority, a disabled or chronically ill person or a person not more than ten years younger than the employee or IRA account owner.
Inheritance checks are generally not reported to the IRS unless they involve cash or cash equivalents exceeding $10,000. Banks and financial institutions are required to report such transactions using Form 8300. Most inheritances are paid by regular check, wire transfer, or other means that don't qualify for reporting.
Before the Secure Act of 2019, heirs could "stretch" inherited IRA withdrawals over their lifetime, which helped reduce yearly taxes. But certain accounts inherited since 2020 are subject to the "10-year rule," meaning IRAs must be empty by the 10th year following the original account owner's death.
If you inherit a Roth IRA, you won't owe taxes on distributions, though you will still be required to empty the account within 10 years. The tax rules are more lenient for spouse beneficiaries. Spouses can roll over the inherited IRA into their personal IRA or put the money into a new, inherited IRA account.
If the decedent died on/after the RBD, annual RMDs must continue over the deceased IRA owner's remaining single life expectancy (the ghost life rule). This can produce a post-death payout period exceeding 10 years.
RMD rules to know: Who, when and how much
If you own a retirement account and have reached age 73, generally you will need to take an annual RMD each year before December 31. First year exception: You can delay taking your first RMD until April 1 of the year following the year you turn 73.
Reducing RMDs With QCDs
A qualified charitable distribution (QCD) can be a great way to reduce required minimum distributions (RMDs) and optimize the tax benefits of giving.